Actuarial Notes

Plan Sponsor

Study guides: Exam CP-321, Exam GH-201C, Exam GH-201U, Exam RET-101, Exam RET-201, Exam RET-301

A Plan Sponsor is the employer, group of employers, union or joint board that establishes a benefit plan — a Retirement Plan, or a retiree health or group benefits program — chooses its Plan Design, pays for it, and carries the risk the design leaves with it. In a Defined Benefit Plan the sponsor's contribution is the balancing item that keeps the promised benefits funded.

UAL_t = AL_t - F_t

C_t = NC_t + \frac{UAL_t}{\ddot{a}_{\overline{m}|}}

C^{\text{sponsor}}_t = C_t - C^{\text{member}}_t

  • Symbols: AL_t is the Actuarial Accrued Liability and F_t the fund's assets, so UAL_t is the unfunded liability (a surplus if negative); NC_t is the Normal Cost; the deficit is amortized over m years with payments at the start of each year. Legislation and the funding policy fix m and the valuation basis.
  • Roles: plan designer, funder (setting funding policy within regulatory limits), fiduciary or administrator, and employer — four hats whose interests can conflict.
  • Risks: in DB the sponsor bears investment, interest-rate, longevity and salary risk, which surface as contribution volatility, balance-sheet liabilities under accounting standards, and cash demands in bad years. In a Defined Contribution Plan its cost is fixed at the contribution rate times payroll.
  • Sponsors manage the risk through design (DC or hybrid plans, benefit caps), investment (liability-driven investing, Hedging) and risk transfer (annuity buy-outs to an insurance company).

The Sponsor's Contribution with a Deficit A plan's actuarial liability is $120{,}000{,}000 and its assets $105{,}000{,}000. The normal cost is $6{,}000{,}000 and payroll is $60{,}000{,}000, of which members contribute 5%. The deficit is amortized over 15 years at 5%, payments at the start of each year. Find the sponsor's contribution as a percent of payroll.

Answer

\begin{align*}
\ddot{a}_{\overline{15}|5\%} &= \frac{1 - 1.05^{-15}}{0.05/1.05} \\
&= 10.8986 \\
C &= 6{,}000{,}000 + \frac{15{,}000{,}000}{10.8986} \\
&= 6{,}000{,}000 + 1{,}376{,}318 \\
&= 7{,}376{,}318
\end{align*}
\begin{align*}
C^{\text{sponsor}} &= 7{,}376{,}318 - 0.05 \times 60{,}000{,}000 \\
&= 4{,}376{,}318 \\
&= 7.29\% \text{ of payroll}
\end{align*}

An Asset Shock Hits the Sponsor's Cash Flow In the plan above, assets fall 15% before the valuation while the liability is unchanged. Recompute the sponsor's contribution and its change.

Answer

\begin{align*}
F &= 0.85 \times 105{,}000{,}000 \\
&= 89{,}250{,}000 \\
UAL &= 120{,}000{,}000 - 89{,}250{,}000 \\
&= 30{,}750{,}000 \\
C &= 6{,}000{,}000 + \frac{30{,}750{,}000}{10.8986} \\
&= 8{,}821{,}453
\end{align*}
\begin{align*}
C^{\text{sponsor}} &= 8{,}821{,}453 - 3{,}000{,}000 \\
&= 5{,}821{,}453 \\
&= 9.70\% \text{ of payroll}
\end{align*}

A 15% market fall raises the sponsor's contribution by $1{,}445{,}134, or 33% — the members' 5% does not move, so the whole shock is the sponsor's.

How it appears on the exam

  • RET-101 asks how plan features, temporary or permanent, can adversely affect the sponsor, and how to identify and prioritize the sponsor's goals — written answers, often with a case study.
  • RET-201 asks for advice to sponsors on funding options, accounting methods and disclosures, and mitigating investment risk; RET-301 asks you to evaluate funding alternatives for the sponsor, shareholders and participants under Canadian pension legislation.
  • CP-321 asks for advice to a sponsor choosing the design of a retiree health program; GH-201C and GH-201U for the impact of regulation (and, in Canada, taxation) on plan sponsors.

Exam traps

  • Charging the whole contribution to the sponsor when members contribute: the sponsor's share is C less member contributions, and only it absorbs gains and losses.
  • Amortizing with an annuity-immediate when payments are at the start of the year, or using the plan's whole remaining life instead of the stated period m.
  • Answering "the employer" when asked for a multi-employer plan's sponsor: it is usually a joint board of trustees, and contributions are often fixed by collective agreement, so benefits — not contributions — absorb shortfalls.
  • Listing only investment risk: a written answer on sponsor risk should also name longevity, interest-rate, salary and plan-design risks (early retirement subsidies, indexing).